Japanese net-nets: update

In 2013 I bought my first couple of Japanese net-nets and expanded the basket the basket with a few more positions in 2014. In this post I’ll list my current Japanese holdings.

There have been a few developments that have led me to buy a few more Japanese positions since the last update in 2014. I will first discuss these developments briefly.

Abe reforms

See: Japan’s Return-on-Equity Revolution. In 2014 the Japanese government has introduced return on equity targets for companies. Also, proxy advisor Institutional Shareholder Services now recommends voting against corporate managements that have not achieved a 5% average ROE over the last five years.

Many people will blow these developments off, because these ROE targets are still very modest compared to US or European standards. But I think these are steps in the right direction that were practically unthinkable just three or four years ago.

Increasing investor interest

Take for example this excerpt from the 2015 FRMO Corp. (run by Murray Stahl and Steven Bregman) annual meeting (bold text mine):

“In Japan, in the last couple of months, not the law, but the attitude of the government has changed about companies that sit on big piles of cash with necessarily very low returns on equity. The government is pressuring companies to manifest at least a 5%, and maybe an 8%, return on equity and doing something with the cash. So, there are actually net-nets there. We’re exploring that possibility. We’d like to create a fund to invest in the net-nets.

To find the net-nets in Japan, you need to be conversant in the Japanese language, because they have no annual reports in English. Happily, we have two Japanese-speaking analysts, and we are actually in the process of compiling a list of companies. We’d love to raise a fund to invest in net- nets. There are other net-nets in the world, but the home of net-nets in the way we think of net-nets is a company with a lot of cash, minimal if any liabilities, and a business that’s actually profitable. That’s the place they’re at. Hopefully we can manage to do something there. And if anybody wants to invest with us, we’d love to talk to them.”

Large market inefficiencies

I posted about the takeover bid for one of my holdings (Hakuseisha) last month. The price offered was a 140% premium over the previous closing price. This was a significant development for me, not just because it was a nice gain for a company in my portfolio, but more because I believe it confirmed I am fishing in the right pond. Hakuseisha is one of these companies with a 1,000 share lot that requires a relatively large minimum investment. I believe this creates large discounts to intrinsic value.

Also, the trading in Hakuseisha in the days after the takeover offer showed that some investors were not very informed or sophisticated. There were daily price limits in place that capped the maximum gain per day of Hakuseisha. A few investors were not aware of this and sold their shares for as little as ¥415, ¥495 and ¥575 when the takeover offer was ¥800. A few days later the price had moved up to ¥798. Even though only 9 lots traded at these much lower prices, it does provide an indication that this odd corner of the market is not very efficient.

Relatively expensive US markets

Two or three years ago I think I had around 40% of my portfolio in US stocks. Today this is just below 30%. I’m not finding a lot of opportunities in the US. Recently I sold a fairly large position in Markel and reinvested a portion of the proceeds in Berkshire (which I sold a year ago, but now looks more attractive in an absolute sense and also relative to Markel) and two OTC listed stocks, the rest I invested in Japan.

Also the strengthening dollar vs the Euro has been a tailwind for my portfolio in 2014 and 2015, but that is not an achievement and will not continue year after year. I think I should be more selective about investing in the US at this point in time. In general you should tend to invest where the news is bad and it has not been bad in the US. There is more negative sentiment in Australia, Japan and some other Asian markets. I’m also finding more potential investments in these markets which is not surprising.

Current basket of Japanese stocks

Sorted by ticker (low to high). Holdings that have not been discussed before in earlier posts are printed in bold text.

  • Okayama Paper Industries (JP:3892), share price: ¥472
    • Market cap: ¥2.7bn
    • Manufacture and sale of paper boards and decorative paper boards
    • 0.47x NCAV (¥5.7bn including long-term investments), 0.33x BV
    • Consistent revenue and profitability. Reasonable free cash flow. Small buybacks in fisc. 2012, 2013 and 2015. Dividend: 2.5%. Cash & investments cover total liabilities.
    • 1,000 share lot
  • Isamu Paint (JP:4624), share price: ¥550
    • Market cap: ¥5.2bn
    • Manufacture and sale of paints, as well as the purchase and sale of related products
    • 0.57x NCAV (¥9.1bn), 0.41x BV
    • Good free cash flow yield, low capex. Lots of cash and investments, almost no debt. Small buyback in 2013 and 2014. Dividend: 1.8%.
    • 1,000 share lot
  • Natoco (JP:4627), share price: ¥947
    • Market cap: ¥7.1bn
    • Manufacture of resin coatings
    • 0.77x NCAV (¥9.2bn), 0.45x BV
    • Relatively large buyback in fisc. 2014. Around ¥6bn of PP&E and therefore substantial capex, but free cash flow positive. Steadily growing book value. Dividend: 2.5%.
    • 100 share lot
  • Daiken (JP:5900), share price: ¥626
    • Market cap: ¥3.7bn
    • Manufacturing and sale of architectural hardware, exterior building materials and other exterior products
    • 0.61x NCAV (¥6.1bn), 0.33x BV
    • Solid free cash flow and growth in book value. No buybacks. Dividend: 2.2%.
    • 100 share lot. Daiken used to have a 1,000 share lot, but it looks like they trade in 100 share lots since November 2015. That could make shares more attractive to small investors.
  • Fujimak Corp (JP:5965), share price: ¥799
    • Market cap: ¥5.2bn
    • Manufacture, sale, maintenance and repair of kitchen equipment
    • 1.58x NCAV (¥3.3bn), 0.41x BV
    • Good growth in book value. P/E: 7.5. Heavy capex in fisc. 2015. Dividend: 2.5%.
    • 100 share lot.
  • SNT Corp (JP:6319), share price: ¥650
    • Market cap: ¥17.0bn
    • Manufacturer of forged products.
    • 1.04x NCAV (¥16.4bn), 0.59x BV
    • Very cash rich company. Good free cash flow. No meaningful buybacks in the last few years. Dividend: 2.2%.
    • 100 share lot.
  • Kikusui Electronics Corp (JP:6912), share price: ¥665
    • Market cap: ¥5.6bn
    • Manufacture and sale of various electronic application equipment.
    • 0.98x NCAV (¥5.7bn), 0.64x BV
    • Consistent revenue and free cash flow. It has a US based subsidiary. Nice dividend of 3.3% and small share buybacks every year.
    • 100 share lot.
  • Car Mate (JP:7297), share price: ¥659
    • Market cap: ¥5.0bn
    • Manufacture and sale of automobile items mainly.
    • 0.79x NCAV (¥6.3bn), 0.46x BV
    • Very small position (reinvested dividends). Business is showing losses in the last couple of quarters. I would not buy this today considering the alternatives. Dividend: 3.0%.
    • 100 share lot.
  • Nansin (JP:7399), share price: ¥403
    • Market cap: ¥3.1bn
    • Manufacture and sale of casters and dollies.
    • 0.89x NCAV (¥3.5bn), 0.36x BV
    • Low capex, perhaps unsustainable given the much higher depreciation charges. Debt reduced from ¥3.3bn in 2011 to ¥0.5bn today. Perhaps greater potential for future dividend increases or buybacks? Dividend: 2.5%.
    • 1,000 share lot.
  • Eidai Kako (JP:7877), share price: ¥300
    • Market cap: ¥1.9bn
    • Manufacture and sale of various synthetic resin molded products.
    • 0.53x NCAV (¥3.6bn), 0.30x BV
    • Pretty consistent performer in terms of revenue, profits and cash flow, but not great in any department. Main attraction is the massive discount to net current asset value and book value. Probably caused by the 1,000 share lot and the fact that this is a very small company (market cap around $15m USD). Dividend: 2.7%.
    • 1,000 share lot.
  • King Co (JP:8118), share price: ¥424
    • Market cap: ¥8.2bn
    • The Apparel division is involved in the wholesale of ladies apparels, fashion goods, apparel accessories, promotion materials, the planning, sale, logistics and clerical work agency businesses, as well as the sale of apparel store promotion items. The Textile segment is involved in the wholesale of textile products, through its subsidiary.
    • 0.88x NCAV (¥9.3bn), 0.42x BV
    • Very small position (reinvested dividends), but perhaps deserving of a normal position in the basket. I’m not really a fan of investing in anything related to fashion though. Strong free cash flow, a good dividend and some share buybacks in recent years. Dividend: 3.5%.
    • 100 share lot.
  • Denkyosha (JP:8144), share price: ¥643
    • Market cap: ¥8.1bn
    • Wholesale of electrical products and household products.
    • 0.63x NCAV (¥9.3bn), 0.34x BV
    • A lot of cash, investments and real estate here. Business did produce a small operating loss in fiscal 2015. Unfortunately no meaningful buybacks. Dividend: 3.1%.
    • 1,000 share lot.
  • Uehara Sei Shoji (JP:8148), share price: ¥549
    • Market cap: ¥9.3bn
    • The operation of industrial energy-related and construction material-related businesses.
    • 0.38x NCAV (¥24.4bn), 0.31x BV
    • What can I say? I basically stole this one from the blog Deep Value Ideas. Besides the extreme discounts to NCAV and BV, the company is regularly repurchasing shares. That’s why the company now holds a massive number of shares (7.3 million) in treasury. Dividend: 1.6%.
    • 1,000 share lot.

Disclosure: long the whole damn list. Long Berkshire Hathaway. No position in Hakuseisha, Markel or FRMO Corp.

Posted in Japanese stocks and tagged , , , , , , , , , , , , .

17 Comments

  1. Hi,
    What are the long term investments that Okayama Paper Industries (JP:3892) & Isamu Paint (JP:4624) are holding?
    Best,
    Don

    • I don’t know. You probably need to do an in depth dive into the Japanese annual reports if you want to get more information about these investments.

  2. Hi Paul!
    Great background information and lots of interesting stocks! I’ve been following the developments for Hakuseisha with great interest — unfortunately only from the sidelines. I wasn’t aware of the price limits. This is very good to know. I agree that this situation demonstrates nicely the inefficiencies in the Japanese market. Thanks for giving credit for Uehara! I appreciate it a lot!
    DVI

    • Thanks DVI for the comment and for the great write-up of Uehara on your blog. I think it is a nice addition to the basket and probably one of the cheapest companies in there.

    • No, I don’t speak a word of Japanese. I do use Google Translate when I look at the financial statements, but there are many limitations obviously.

      My solution is to mainly buy companies that are cash rich, trading at extreme discounts to NCAV and/or BV, are stable performers in terms of revenue and profits / free cash flow and above all: to diversify. I believe the basket as a whole will do well, but the performance of individual companies is unpredictable. For example: I didn’t see Hakuseisha as one of the most attractive stocks in the basket before it received a takeover offer. For investors who take a more concentrated approach or investment managers who need to defend their decisions to their clients it is more important to have in depth knowledge.

      • Good to know, thanks. I think your strategy is a good one, and you seem to end up with fairly good quality businesses at reasonable prices. I think I’ll learn quite a bit reading your blog and hope you keep posting!

  3. Nice post. Uehara seems like a cool new find. We have quite a bit of overlap in our baskets (probably because I am lazy and copy your ideas). I’m not as enthousiast as you about the deep value names. For example, Denkyosha sure is cheap but ROE and capital allocation are horrible. It probably should trade at a discount. I prefer things like Nansin where at least book value increases by a decent clip per year while you are waiting for something to happen.

    Probably just a style thing, I’m sure a basket of Denkyosha’s will do great in the long run and I own a couple of them nonetheless.

    p.s.: I was trying to buy the Japan Company Handbook today. Available on Amazon Japan but i think it is a bit too price (~$100 including shipping). Anybody has a cheaper option?

    • Yes, I think Nansin looks a bit more attractive than some of the other ones in the basket. I don’t think it matters a great deal though. Most of the upside for these stocks depends on things we can’t predict, like management allocating capital a little better in the future or a takeover by another company.

      One company that I really liked and owned a few years ago was Maruzen (5982). Very good free cash flow, a low P/E, a nice discount to book value: a lot to like. It was getting cheap again lately, so I was thinking of buying back in. Then I noticed they did a small stock issuance of 150k shares at a small discount to the market price. No idea why. The company has plenty of cash. Even though 150k shares is not that much considering there are 18.7m shares outstanding, this makes no sense at all to me and the shares have also sold off a bit in the market, I think as a result of this issuance. Maruzen was definitely one of my “best” ideas in Japan. Then this issuance comes out of nowhere and now I don’t really want to touch it anymore.

      This Maruzen issuance and the Hakuseisha takeover just reminded me how heavily the outcome depends on things I can’t predict. Also, in both cases I don’t think it would have helped me much if I had done a lot more research.

      Japan Company Handbook: I’ve thought about buying it. I know Nate from Oddballstocks bought one a few years ago. Just a bit too expensive for me. I don’t think there are cheaper options. There are no listings on Ebay. Personally I’d rather spend some time doing some screens on the free FT.com screener once in a while and looking up companies on Kaijinet.

  4. Thank you for this post. I noticed that at least some of the holdings mentioned in your post (e.g. Okayama Paper industries, Nansin) cannot be bought in Germany, because the stocks are not safekept at Clearstream.

    I wonder if you use a Japanese stock broker/bank?

  5. Noticed that all the jap companies have pretty crappy dividend yield. this might point to a controlling shareholder not wanting to share the cash and assets with OPMI. This in turn might make them mostly value traps…

    • Capital allocation is the major problem among many Japanese companies. I don’t think the issue is controlling shareholders at these companies. I think it is mainly a depression mentality that still rules Japan’s companies ever since their stock market bust in 1990. Richard Koo wrote a great book about this called “The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession”. Not to sure about his macro theories, but I found the discussion about the whole Japanese mindset post-crash very interesting and helpful in understanding why we’re seeing the valuations and cash heavy balance sheets at so many Japanese companies today.

      The government is now taking some steps to push companies in the right direction. It remains to be seen if this will help.

      Even if these companies “stay cheap forever” as I often hear people say, I think it is just tough not to make money when you buy a profitable, dividend paying, cash-rich company trading at 30-40% of book value. How much cheaper can it realistically get? I don’t think I can find any stock on the planet that has the characteristics of these companies and that is trading for, let’s say, 10-20% of book value. If someone has some, please send me a note. 🙂 (Hong Kong / China real estate companies don’t count)

  6. “What are the long term investments that Okayama Paper Industries (JP:3892) & Isamu Paint (JP:4624) are holding?”

    For Okayama:

    Okayama Paper Industries CO., Ltd. (3892) 2,081,696 29.7%
    KOKUYO CO., LTD. (7984) 177,950 0.14%
    Fuso Pharmaceutical Industries Ltd (4538) 335,992 0.36%
    Marubeni Corp (8002) 89,800 0.0052%
    TAKARA HOLDINGS INC. (2531) 61,000 0.028%
    Kirin Holdings Co Ltd (2503) 29,491 0.0032%
    Rengo Co Ltd (3941) 78,912 0.029%
    FURUBAYASHI SHIKO CO., LTD. (3944) 59,200 0.33%
    Daio Paper Corporation (3880) 2,000 0.0013%
    Nomura Holdings, Inc. (8604) 1,000 0.0000%

    For Isamu Paint:

    Isamu Paint Co Ltd (4624) 2,457,000 20.5%
    Daicel Corp (4202) 99,985 0.027% 1,
    Sumitomo Mitsui Financial Group, Inc. (8316) 21,000 0.0015%
    Japan Airlines Co Ltd (9201) 20,000 0.0055%
    Dai-ichi Life Insurance Co Ltd (8750) 11,300 0.0009%
    Ms&Ad Insurance Group Holding Inc (8725) 3,600
    SHO-BOND Holdings Co., Ltd. (1414) 1,300 0.0045%
    ISHIHARA SANGYO KAISHA, LTD. (4028) 50,000 0.012%
    Mizuho Financial Group, Inc. (8411) 11,000 0.0000%
    Nippon Synthetic Chemical Industry CoLtd (4201) 1,000 0.0010%

    Why do you only invest in J-Nets? Japan offers also good companies reasonably priced.

    http://undervaluedjapan.blogspot.de/2012/04/hogy-medical-jp3593-it-has-not-always.html

    • I mostly stick to net-nets because I like the protection the (often liquid) assets offer. Some of these businesses also seem pretty decent, but they are not great businesses.

      It also has to do with the language barrier. Since I can’t read Japanese it is often impossible for me to get a level of understanding that is comparable to a US listed company. Sticking to an approach of buying companies trading at large discounts to NCAV and selling them when they reach NCAV is simple and should perform well over time, I think.

      I wouldn’t be able to know enough about a “quality” Japanese business trading at perhaps 12x earnings to determine that it really deserves a 20x multiple. Instead I would worry about missing important information if that business deteriorates and the company falling back to the valuation that some of my net-nets currently have.

  7. Pingback: Solcom (TYO:1987) looks cheap, Sold Fujimak (TYO:5965) | ValueInvestingBlog.net

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